Hovnanian Enterprises Inc (HOVNP) 2008 Q2 法說會逐字稿

Good morning, and thank you for joining us today for the Hovnanian Enterprise fiscal 2008 second quarter conference call. By now you should all received a copy of the earnings press release. However, if anyone is needing a copy and would like one, please contact Donna Roberts at 732-383-2200. We will be sending you a copy of the release and ensure that you are on the company's distribution release. There will be a replay of today's call. This telephone replay will be available after the completion of the call and around for one week. The replay can be accessed by dialing 888-286-8010. The pass code, 21484758. Again the replay number is 888-286-8010. And the pass code is 21484758. An archive of the webcast slides will be available for 12 months. This conference is being recorded for rebroadcast and all participants are currently in a listen-only mode. Management will make some opening remarks about the second quarter results and then open up the lines for questions. The company will also be webcasting a slide presentation along with the opening comments from management. The slides are available on the investors page of the company's website at www.khov.com. Those listeners who would like the follow along should log onto the website at this time.

Before we begin, I would like to remind everyone that the cautionary language about forward-looking statements containing the press release also applies to any comments made during this conference call and for the information in the slide presentation. I would now like to turn the call over to Ara Hovnanian, President and Chief Executive Officer of Hovnanian Enterprises. Ara, please proceed.

Good morning, and thank you for participating in today's call to review the results of our second quarter and six months ended April '08. Joining me from the company today are: Larry Sorsby, Executive Vice President and CFO, Kevin Hake, Senior Vice President and Treasurer, Paul Buchanan, Senior Vice President and Chief Accounting Officer, Brad O'Connor, Vice President and Corporate Controller, and Jeff O'Keefe, Director of Investor Relations.

The home building industry continues to face challenging market conditions, during these tough market conditions our focus has remained on reducing inventories, reducing costs, generating positive cash flow and improving the liquidity of the company. If you turn to slide number one you can see that the performance of the first quarter in most key metrics was off from last year's second quarter. We gave all of this data along with some additional detail in our press release which we issued yesterday. I'm not going to go over each data point, but instead will focus on some of the key parameters deriving our performance as well as our current initiatives.

Whether you look at our data, the other publicly traded builders or the Census Bureau data, recent sales reports have continued to exhibit negative trends as we have seen for the past two years. On slide number two, you can see our sales per community by quarter for '06 through '08. In each quarter of '07, sales per community were off from already low levels in '06. Unfortunately this trend of declining sales per community has continued through '08. However I do want to point out that our net contracts per community for the second quarter only declined 17% compared to the 29% decline that we reported for total net contracts. The 29% decline in total net contracts is partially related to our 13% reduction in the number of actively selling communities year over year. One of the primary reasons that both the home building industries and our sales are so weak is because as we look across the country we see that existing home inventories remain at persistently high levels.

On slide three, we show single family existing inventory both in absolute units and in terms of months supply. Clearly the number of months supply has increased dramatically over the last two years, however, interestingly, it's only slightly above the levels achieved during the housing downturn of '90 and '91, 10.7 months supply currently versus 9.5 month's supply in that downturn. And it's actually less supply than the 1982 housing downturn when the number of month's supply was 13.8%. However, we need to see the number of month's supply of existing home inventory come down to healthier levels before we're going to start to see any kind of sustained pick-up in new home sales. The point I'm just trying to make is that we are not in unchartered territory when it comes to the level of existing home inventory. Broadly speaking, almost all of our markets remain difficult, some more than others. In order of worst to best, our Florida and California markets remain the most challenged markets today. Markets like Arizona and the midwest also have been through some difficult times, but are are operating at slightly better levels than California and Florida. Our operations in the Carolinas, Washington D.C. and the northeast are holding up better than most of the other markets, but still have been significantly impacted by the housing downturn.

On the top of the list of relative performance today, our Texas operations are doing the best, but even here we have seen some weakness over the last six months. Perhaps the best demonstration of the fact that there is a lot of psychological impact, more than just fundamental supply and demand impact on home buying today, we have the example of Houston, Texas. With oil hovering around $130 a barrel, the local economy and employment are doing very well in Houston. There was little if any speculative home buying in this market at the peak since there was very little price negotiation that attracted speculators in other markets. And the supply of existing homes listed for sales is only slightly above average, yet new home sales activity in Houston over the last few months has slowed down. While many factors affect demand, clearly the negative media attention on housing is impacting consumer confidence and is thus affecting home buying decisions even in fundamentally solid markets like Houston, Texas. In response to the challenging market conditions, we continue to use a playbook that we successfully followed in the numerous other downturns that we have navigated through over the past 49 years, since my father founded our company. We have essentially stopped signing new contracts to buy land parcels. As a result our community account has been decreasing.

If you turn to slide four, you see that at April 30th, 2008, we have 379 communities open for sale, a 16% reduction from 449 communities open for sale in July of '07. While we're not giving a formal estimate for the number of communities at year end, we would expect to see a continuation in the trend of sequential decreases. As our community count declines, our staffing levels continue to come down as well. You can see this on slide number five. This is clearly one of the more painful but necessary aspects of an industry downturn, similar to what we have had to endure in the past. We will continue to right-size our staffing levels based on the current market conditions. At the end of May, we were down 54% from our peak staffing levels back in June of 2006.

On slide number six, you can see some information on total SG&A. On the right-hand side of the slide, we show that we have made significant gross dollar reductions in the dollar amount of SG&A expenditures, with second quarter total SG&A dollars down 24% year over year from $157 million spent last year to $119 million spent over the same quarter this year. However it is going to take time to get back to the lower historical percentages shown on the left-hand portion of the slide which is more typical. While the majority of our SG&A costs are variable and we've been making significant reduction in costs, it is difficult to cut costs as rapidly as our overall business revenues have declined. The reduced levels of sales per community also complicates our ability to quickly return to our historical SG&A costs as a percentage of revenues. For example, at a particular location it is hard to reduce the costs of maintaining models and opening a sales office. Yet as sales go down annually at one location, our costs remain the same, and therefore, our costs per home increases.

We continue to focus on reducing the number of lots we control. On slide seven, you can see that our owned lot position is down 31% from peak levels, and our option lot position is down 69% from peak levels. We accomplished this reduction by purchasing fewer new lots we delivered homes on and from walking away from options. To illustrate this point our owned lot position declined from 27,372 lots in January of '08, to 25, 264 in April of '08. We delivered about 2,500 homes, sold about 500 lots and off-setting this we took down about 850 lots, this resulted in a little over 2,100 lot reduction in lots owned. In our worst markets like California and Florida, we are currently not buying any new lots. However, in some of our markets such as Texas, New Jersey and D.C., we are still replacing some lots, primarily under existing option contracts that have been renegotiated, but on a less than one for one basis. So our land position is reducing in these markets also. Most of these lot takedowns have been renegotiated both on pace and price so that it makes sense in today's market.

On slide eight, we show our owned and option lot position by our six geographic segments. On the right-hand side of this table you see that our owned lot supply is on average 1.9 years times our -- based on our trailing 12 months deliveries, but obviously you can see it varies from market to market. On slide nine, you can see how our land position stacks up to those of our peers. It's sorted by the owned land supply based on trailing 12-month deliveries. While 1.9 year supply is more than we would like to own at this moment, relatively speaking we're in good condition. The good news is that each quarter we worked through more of our owned land, and we will eventually replenish our land supply with lower cost land as we've done with every cycle in the past.

We also continue to bring down our level of started, unsold homes as you see on slide number 10. At April 30th, '08, we had 1,503 started unsold homes which is off 54% from peak levels and it is off 43% from the end of last year's second quarter. Based on our recent sales pace, this represents about a two-month supply. While existing home inventories remain a concern, we do not believe that new home inventories represent nearly the same amount of problem despite the Census Bureau data. On slide 11, we show the number of spec homes on publically traded builders reported as of the end of their most recent quarter and as of a year ago. The year over year change is a 39% reduction, only slightly less than our 43% reduction. The large public builders control about 24% of the market. I find it hard to believe that the private builders who are not reporting in the same manner are starting the number of specs that are being reported by the Census Bureau.

I'm not sure what is causing the noise in the Census Bureau data, but there appears to be some disconnect with the 10.6 month's supply that was reported last week and what is publicly being reported by the large public builders. Given our focus on managing these components of our inventory, we are pleased to see a sequential reduction in inventory on slide number 12. Here we show our dollar investment in inventory broken out in separate categories, First, sold and unsold homes, which includes homes that are in back log, started unsold homes and model homes. And number two, land, both finished lots and lots under development which are associated with all other owned lots that do not have any sales contract or any vertical construction. We reduced our total dollar investment in these inventory categories by 34% since the peak level in July of '06, and we plan to make further progress in reducing our inventories through the balance of '08 and '09. The best way for us to accomplish further reductions is to continue selling and delivering homes on the lots we own. No matter how you slide it the market however remains difficult. Given these conditions our focus is on maximizing our liquidity to weather the downturn and ultimately to take advantage of opportunities to buy land at lower prices as the market bottoms out.

Now let me turn your attention to recent steps we've announced with respect to increasing our liquidity. We've been working on a multi-prong strategy to raise cash and put our company on an even more solid financial footing. The first and most important component of our strategy is cash flow from operations. We accomplished this by reducing overhead costs and spending less on new land and land development than we are receiving on lots we are liquidating through the delivery of homes. As seen on slide 13, we generated $56 million of positive cash flow during the second quarter which was one quarter earlier than our expectations, bringing us to an cumulative amount of roughly break-even cash flow for the first six months, a time when we have historically been very negative. We expect to generate cash flow over the final two quarters such that our home building cash balance at October 31, '08, is projected to exceed $800 million.

Slide 14, the second prong of our liquidity strategy was to sell common share to investors in the secondary offering. A few weeks ago we raised $126 million of cash through the sale of 14 million shares of common stock. Although we remain extremely sensitive to the dilution of our shareholders, especially given the high ownership interest held by my family, we felt this step was prudent given the challenging marketplace and uncertain timing of a recovery. Additionally we sold $600 million of senior secured bonds, which was the third component of our multi-prong strategy to raise cash and solidify our financial foundation. In conjunction with the bond offering, we also amended our revolving credit facility. On this slide you can see some of the key changes to this credit facility. In summary we reduced the commitment to $300 million and substantially eliminated the financial maintenance covenants. Going forward, the primary use of this facility will be for letters of credit. The maturity remains unchanged at May 2011. Virtually all of the public builders, including our company, have requested and obtained one or more amendments to their credit facilities for tangible net worth, leverage and other maintenance-related covenants. So far the banks have approved these amendments for the large public builders, but they have typically required a tightening of availability or other restrictions in return. We are concerned that pressures from lenders could intensify over time and we didn't want to be caught in a position where our liquidity was being restricted at just the wrong time. The issuance of our five-year secured bonds and the amendment and reduction of our credit facility gives us the liquidity we need while substantially alleviating this risk.

We still needed a facility that would permit us to issue letters of credit, but we are are able to limit nature all of the financial maintenance covenants other than a minimum liquidity test that we feel very confident we can still comply with through the most challenging of times. Through the combination of our ability to generate cash internally, together with the issuance of secured bonds and amendment to our credit facility, we have essentially taken liquidity concerns about our company off the table. We continue to make positive progress on another component of our liquidity strategy which is to team up with a financial partner to form a joint venture to opportunistically purchase and develop new properties at the bottom of the housing downturn. We are nearing completion of an agreement in this regard. This structure will allow us to preserve capital and liquidity and reduces leverage further by investing more efficiently with superior returns on equity while growing our earnings as the housing market begins to recover.

We are confident that our recent capital market transactions not only raise cash and enhance our company's ability to weather the housing storm, but they position us to prosper in the inevitable recovery. After giving effect to the transactions at the end of April, we would have had zero borrowed against our credit facility and had about $500 million of cash. For the remainder of the year, we expect to generate strong cash flow and end the year with cash in excess of $800 million. I'll now turn it over to Larry Sorsby to discuss some of the changes we took in the second quarter -- excuse me, some of the charges in the second quarter, and some of the topics in greater detail.

Thank you, Ara. I'll start by talking about the land related charges that we took in the second quarter. Land option walk aways was the smaller component of the second quarter charges at $19.5 million. We walked away from 3,745 lots in the second quarter. If you turn to slide 15, it shows the geographic breakouts of these charges, which represent the amount invested in these options, primarily through option deposits, but also any pre-developments dollars we had invested in getting this land through the approval process. Our land option positions have come down dramatically. In our two most challenging markets, we don't currently have significant exposure to land options. In Florida, we have less than 1,000 lots under option and none of those will be taken down fiscal 2008, and less than 50 lots for a purchase price of about $1.7 million are expected to be taken down in fiscal 2009. We see a similar situation in California where we only have 1,335 lots under option and none to be taken down in the remainder of fiscal 2008, and only approximately 400 lots for a purchase price of $5.6 million expected to be taken down in fiscal 2009. And those are under recently renegotiated options that modify prices and terms.

In some of the other difficult markets such as Minnesota, Arizona, and Chicago, we have slightly less than 1,000 lot options in aggregate remaining. 80% of our total remaining lot options are in better performing markets of Texas, Washington, D.C., the northeast and the Carolinas. For many of these options, the price returns or both have already been renegotiated. Nonetheless, we are consistently re-evaluating every single lot option before we exercise our right to buy even a single lot. For any lot options that we're taking down today, it has to make economic sense on a go-forward basis based on current sales prices and current sales paces. Our remaining investment in lot option deposits have dropped dramatically from a peak of $466 million at the end of the second quarter fiscal '06, to $119 million at April 30th, 2008, $75 million of which is in cash deposits and the other $44 million of deposits are being held in letters of credit.

The next category of pre-tax charges relates to impairments. As shown on the slide, we incurred impairment charges of $226 million related to land and communities that we owned in the second quarter. During the second quarter we mothballed 11 communities. To date, we have mothballed land in 28 communities. The book value associated with these 28 communities at April 30th, 2008, was $493 million net of an impairment balance of $131 million. We mothball communities when we determine the current performance did not justify further investment at this time. We continue to communities to determine if mothballing is appropriate. We would prefer to avoid spending money to improve land today and save the raw land until such time as the market improves and we can generate higher returns. Looking at all our communities, we have a book value $2.9 billion, net of $480 million of impairments on 95 communities that are open for sale and/or under development, and net of $79.1 million of impairments recorded on eight communities in planning.

Turning to slide 16. It shows our remaining investment in land and land development totaled $1.35 billion on a consolidated basis at April 30th, 2008. In our two worst performing segments, the southeast and west, which include Florida and California, our exposure to additional impairments is limited as our investment in the southeast is now only $111 million, and in the west it has declined to only $294 million. There has been much discussion about how home prices need to drop more. Indexes, like the Case-Shiller Index, only track existing home prices. We agree that existing home prices need to come down more, but the new home builders, including us, have been aggressive on dropping sales prices.

Turning to slide 17, we show an example of a community in California and another example of the community in Florida that have seen substantial price declines over the past year and a half. In both cases, prices, as you can see on the slide, have been reduced by almost 40%. But just to illustrate that California and Florida are not the only states where we have experienced steep declines in net prices in homes, turning to slide 18, we show examples of communities in Virginia and another one in Minnesota, which have both seen price declines in the 20% to almost 30% range over the last year and a half. We test all of our communities at the end of each quarter for impairments, regardless of whether or not the community is open for sale or not. If we experience further declines in home prices, we would expect to see further impairments in future quarters. Additionally, during the second quarter of 2008, we took $5.1 million of impairments on land that is owned in joint ventures. This was primarily on land in Chicago, Florida and Virginia.

That leaves us with the last major area of charges for the quarter, which is related to taxes in the FAS 109 deferred tax asset valuation allowance. Normally when we record losses, we would be recognizing a tax benefit. Many of the losses primarily related to impairments of land are not eligible for tax refund until we actually sell the inventory, but the tax benefit can be carried forward for 20 years. So almost every pre-tax dollar of land-related impairments results in an equal after tax dollar sent to our net income and our equity. We concluded that we should book an additional $120.6 million after-tax noncash deferred tax asset valuation allowance during the second quarter.

Let me reiterate what I said on our last two conference calls. The FAS 109 deferred tax asset valuation allowance is for GAAP purposes only. For tax purposes, our tax assets may be carried forward for 20 years and we fully expect to utilize those tax loss carry forwards as we generate profits in the future. While our deferred tax asset valuation allowance charge was noncash in nature, it did affect our balance sheet and our net worth by $120.6 million during the quarter and $357.5 million to date. After our land option walk aways land impairments and an additional FAS 109 deferred tax asset valuation allowance, we ended the quarter with $850 million in total shareholders equity.

Now let me touch very briefly on the mortgage markets and our mortgage finance operation. If you turn to slide 19, our recent data indicates the average credit quality of our mortgage customers remain higher than national averages. Our average loan to values remain at about 85%. Adjusted rate mortgages only made up about 3% of our total originations and FICO scores remain pretty high at 717 and our capture rate at 75%. If you turn to slide 20, we show a breakout of the various loan types originated by our mortgage operations during the second quarter of fiscal 2008 and for all of fiscal 2007. The most noteworthy data point on this slide is the sharp increase in the percentage of FHA VA loans. For all of 2007, FHA VA loans represented only 8% of our total loan origination for '06. And it was just slightly lower -- excuse me in '06 -- in '07 it was 8%, in '06 it was slightly lower at 7%.

Similar to national trends, we saw FHA and VA percentage of originations jump to 34% in the second quarter of fiscal '08. We currently have more mortgage products available today than we did five, six, seven years ago, but not as many as we did two or three years ago when subprime and Alt A was very popular. The industry is going back to mortgage lending 101 basics. The market has just returned to sound mortgage credit underwriting criteria principals. Buyers who have a decent credit history, can verify their job, and make a modest down payment have no issues of obtaining approval for conventional, jumbo, FHA or VA loans. Now I'll turn back to the performance of our home building operations in the second quarter.

If you'll turn to slide 21, you can see that our cancellation rate peaked during the fourth quarter of 2007 at 40%. It came down slightly in the first quarter to 38% and declined further to 29% in the second quarter of 2008. The trend has been moving towards a more normalized cancellation rate that would be in the mid-to-low 20% range. For the quarter we had land sales of $3.7 million, and general land sales activity remained slow across the industry. Well we likely will see our new joint venture with a handful of our communities, it is unlikely that we'll participate in any significant bulk land sale transactions. Our contract backlog at April 30th, 2008, excluding unconsolidated joint ventures was 3,577 homes with a dollar value of $1.2 billion. Reflecting on the continued weakening of the housing market and our efforts to reduce started and unsold homes, our home building gross margins remain at historically low levels. On slide 22, you can see that our gross margin fell again to 6.8% during the second quarter of 2008. During the second quarter of 2008, our cost of sales was reduced by $38.3 million from the reversal of land impairments taken in prior periods.

Now I'll shift to talking about joint ventures. At April 30th, 2008, we have invested $166 million in nine land development and 10 home building joint ventures. If you turn to slide 23, it shows that we have continued to maintain modest leverage in joint ventures and have financed them solely on a nonrecourse basis. At the -- at quarter end our debt to cap of all of our joint ventures in the aggregate was 46%, significantly lower than our consolidated leverage. We do not have any debt arrangement or guarantees at any of our joint ventures that would require us to provide additional equity capital to our joint venture in the future and we don't anticipate a need for us to voluntarily invest additional cash to support our joint ventures beyond the amount that was budgeted to be invested by the partners originally. The majority of our joint ventures are in the advanced stages of development. And thus the amount of budgeted equity investments has largely been invested already. In fact we expect to generate cash from our joint ventures as a number of them are in the wind down stage of delivering homes without significant additional development dollars needed.

We report significant details on the balance sheet and profits of our unconsolidated joint ventures as well as assets in our 10Qs, Ks, so you can look there for more detail. I'll now turn it back to Ara for some closing comments.

Thanks, Larry. It appears that the remainder of fiscal '08 will be difficult for the industry. If this housing correction follows the pattern and duration of the 1975 correction, the housing market should start improving in 2009, just in time for our company's 50th anniversary celebration. On the other hand, if this housing correction should follow the pattern and duration of the 1981 correction, 2009 could remain as another difficult year, similar to 2008. One unknown is the partial -- potential effect of the housing stimulus bill, a version of which has passed both the Senate and the House and is now being considered in joint committee. This could affect consumer confidence and consumer pocket books in the short term and could have an immediate impact on the housing market. Nonetheless, our community level budgets assume no near term improvements in existing sales pace or price.

Given the lack of visibility that we have as to when the market will turn, we have taken recent steps to enhance our liquidity as we have discussed. Having the liquidity to weather the downturn is more important right now than ever before. Ultimately we will also need to have the liquidity to take advantage of land at the bottom. And we discussed a bit of that regarding our joint venture strategy in addition to our own capital. With the capital we have raised, both debt and equity as well as our cash flow expectations for the rest of the year, we believe we have taken all the liquidity concerns off the table. Based on our projected cash flow for the year, we expect to end the year, once again, with more than $800 million worth of cash and nothing drawn on our revolving line of credit. Additionally we have taken additional steps to reposition ourselves, reduce our overhead and be better prepared with an environment with lower sales, pace and pricing. As you know our company has endured many housing corrections in our 50-year history. In each of the downturns we have been through, we have emerged as a better and stronger company and we remain confidence that we will do the same as this market recovers through this cycle as well.

Next year we'll celebrate our 50th year as a home builder, as I mentioned earlier. And hopefully we're going to see signs that the recovery is not too far off. We are much smaller in the past downturns that we are now, we're much less diversified, we have far fewer products and price points and are in far fewer geographies, we also had typically higher leverage than we are operating with today. Yet we managed through those difficult times in the past, and we are taking the steps now that we know are necessary to come through this downturn and ensure we are in the best possible position for when the inevitable recovery does take place. One thing is certain, if you turn to slide 24, and that is that home building is here to stay. Virtually every demographer and actuarialist agree that the population and number of households are growing at a faster pace this decade and the next than in any of the last three decades. This should ultimately lead to greater housing demand than in the past. Number two, the housing market will eventually recover into more normalized levels. We are in a cyclical market. It is not going to stay down forever. And three, there are far fewer competitors in the housing industry today as undercapitalized private builders are closing their doors all around the country each and every month. And many of the private builders that do survive will be severely constrained.

Increasing demand and greatly reduced competition creates a very favorable financial environment for the remaining home builders that have ample liquidity. We have seen it many times in our 50 year history, we will see it again with this recovery. Hovnanian will emerge as a better and stronger home builder as we have every time in the past. That concludes our formal comments. And we're pleased to open up the floor for questions.

The company will now answer questions. So that everyone has an opportunity to ask questions, participants will be limited to one question and a follow-up, after which they will have to get back into the to ask another question. At this time we will open the call for questions. (OPERATOR INSTRUCTIONS) All questions must be submitted at this time in order for it to be registered. Questions will taken in the order received. (OPERATOR INSTRUCTIONS) And please stand by for the first question. And the first question comes from the line of Ivy Zelman with [Zerman]. You may proceed.

Hi, good morning, I appreciate the opportunity. I wanted to focus in on your underwriting standards, Larry, in terms of how you're carrying your assets. If I heard correctly, you're using today's prices for not only impairments but for also for take down or exercises of options on land you control. Realizing we're in a deflationary environment, wouldn't it be more prudent to assume that home prices continue to fall, rather than having to continue to have more impairments in the future? Why not expect them or utilize the deflationary expectations that the market has?

Yes. That is one point of view, Ivy, we have this one of point of view of that the markets are down a lot, at some point it's going to turn, you can't continue to see home prices go down forever, so we have never done anything other than take current prices and current pace. Our crystal ball is no better than anyone else's. We don't know what the future holds, whether it's going to continue to slide down or whether we're going to stabilize. At some point it will actually go the other way and we will be criticized if we over impaired. So our approach has always been that we look at it based on current prices, current paces, and we think it's a prudent approach to take.

And, Larry -- thank you for that. In terms of your margin performance excluding impairments, we show -- at least my calculations would show that you're on a negative operating basis, excluding impairments, a negative 9%, and with impairments, negative 40% if my math is correct. Assuming that is right or roughly in the ballpark, it would appear that if prices continue to fall, at some point the homes you're delivering you will be generating no cash on those homes. Where are you on the cash generating per home, realizing that you do have some costs that you're recovering on land, and giving me aggregate numbers of losses excluding impairments, would that not imply that you have got a lot of impairments?

That is a long question. I'm not sure that I got all the components of it down, Ivy, but I'll attempt. The easiest response I can tell you is that we expect our cash balance at the end of the year to be $800 million at the end of April pro forma for the transactions we did, it was $500 million, so that is an increase of $300 million in cash. So I guess you're asking how much is it on a per home basis. There is no easy answer to that. Averages don't make a lot of sense to anyone.

But if you end up dividing the number of deliveries that we have between the end of April and October, into the $300 million, I guess that is one way to measure it. But I don't think that is necessarily representative, because we're usually less cash flow positive in the first part of the year. And more cash flow positive in the back end of the year. So it is a difficult question to give you an absolute straightforward answer on. But at this stage given with the impairments that we have taken we're confident that we are in a cash generation mode and I think that's evidenced by the comments that we've made both in our release and in the script today.

Obviously, Ivy, there's differences between GAAP reported earnings an cash flow. And even if you don't have decent reported earnings, that doesn't mean you're generating cash flow as evidenced by what we're projecting for the balance of the year. While margins have been disappointing, there are a few things going forward that are moving in a positive direction. Some of that includes the mix of the homes and communities we have coming up, is a little better than what we've gone through. Many of the impairments we've taken are going to be reversing a little more aggressively later. We have renegotiated many of the land contracts. Some of those homes are going to be delivering, we've renegotiated some of the subcontractor costs. Those homes are going to be delivering. It's hard to know how all that plays out with home prices, but at least there are definitely some positive things that are countering home prices for the future quarters.

Well now that you guys have a much better capitalized balance sheet relative to what it was prior to equity raise -- debt placement, could you kind of help us understand how much more flexibility you may have now in being aggressive to improve your velocity and absorption rate? Would you be willing to give up some margin now to generate more sales because you have the balance sheet that enables you to do it today?

Well, we have had -- frankly, we're constantly looking at this balance between velocity and margin. And if anything, when times are more challenging, you're more inclined to work on and not worry about margin. But I wouldn't say we changed our philosophy in that regard. We look at each and every community. We look at essentially how many dollars are being recovered on the lot if you build a house on some of our poorer performers. And what we're not getting a decent lot recovery by building a house and delivery it for the customer, then we're mothballing some of those communities. And we're not afraid to do that on the good parcels that we believe in for the longer term. On the other hand where we can get velocity with price decreases, we're not afraid to do that. We would like the burn through as much of our land inventory as we can reasonably do, clear our balance sheet, generate the cash, and make room for the new land purchases at the better economics.

Okay. Thanks, guys.

You bet. Thanks, Ivy.

And the next question comes from the line of Carl Reichardt from Wachovia, you may proceed.

Good morning, guys. How are you? Ara, you made a comment about considering a relationship with a partner for effectively co-investing at the bottom going forward. Did you intend this to be a permanent change on how you think about investing or more a temporary cyclical one, and do you expect other builders in this industry to pursue similar arrangements?

Well, it is interesting, Carl. Up until four years ago we did 100% of everything with our own capital. About four years ago we ventured into a few of our first joint ventures with financial partners. And they were in communities that required a little more capital, sometimes mid-rise in a few of the cases where we actually built a high rise in those cases, or where they were just big land purchases. The structure was that we would put up a much smaller amount of the -- a much smaller amount of the equity, but if the communities perform, we get a disproportionate share of the properties. Since we began that we have done numerous joint ventures with Lehman Brothers, [Waxstone], Morgan Stanley, and a host of top financial partners. I can tell you overall while the market hasn't been cooperative recently, the experience has been a good one, and the notion -- and by the way, all of those we've done with nonrecourse debt, with minimal leverage, as Larry reported, even with our recent impairments, we're still at about 46% debt to cap, so conservatively financed as well.

There is a case to be made that having a larger proportion of the -- of our operations at joint ventures makes sense, but at this point we're not planning on a major shift, but slightly increasing our previous target. I think in the past we said 10% to 20% of our equity might make sense in a joint venture mode. I think it is likely we may raise that especially as our equity is going down in the immediate term. But it is something short of saying that this is going to be the fundamental way we're going to go forward permanently.

Okay, thanks for that. Just as a follow-up, we're talking about the elimination of private home builders on a greater rate. But given the public builders at least at this point seem to have some avenues open for liquidity raises and continuance of existence. And there appears to be a relatively large amount of capital building up on the sidelines from other sources looking to involve itself in the business, are you confident that the opportunities at the bottom of the landmark that are going to be available? You may be losing private builders, but there's a ton of capital on the side and a lot of publics looking too. How do you sort of think about that --

Well, the public builders, we have traditionally through the good times had plenty of capital. We're used to dealing with them. But we had to deal with the bigger portion of the market, which is the private home builders. They are still the majority of the market. So public builders will continue to have liquidity availability, that doesn't change, but the private builders will not, or they will be -- not obviously across the board. There are many that find private builders. But as a generalization they are much more thinly capitalized. So net-net publics and privates, I would think there will be good opportunities. And while there are venture funds out there buying land, they are not home builders. And they will be out there to sell land to people like ourselves that will make the profits building the houses.

Ladies and gentlemen, so that everyone has an opportunity to ask questions, participants will be limited to one question and a follow-up. And the next question comes from the line of David Goldberg. You may proceed.

Question -- first question is about foreclosures and the impact of foreclosures on your communities. And if you're seeing a significant amount of price pressure that is coming from foreclosures in nearby communities.

We are definitely competing with foreclosures in certain markets. See it more really in Florida and northern California, for whatever reason. We see more of the competition from foreclosures in those two markets specifically. That has been a headache, that does drag down pricing. But it's something that we're dealing with and we feel we are currently priced appropriately to compete with the foreclosures. Generally speaking the foreclosure -- a comparable home in the foreclosed state has a lower value and they're appraising at lower values. So that is of some benefit. Hopefully, the worst -- if everybody is correct, the worst of the resets are behind us and it gets a lot easier in terms of new homeowners reaching monthly payment increases that are difficult for them and the rate of foreclosures will start decreasing, certainly has been the projection. At the moment, though, there has been an increase over the last six months clearly. And we are competing with that day-to-day, particularly in two of the markets that I've mentioned.

But doesn't that suggestive we're competing with the existing home market, whether or not we assume there's more foreclosures or fewer foreclosures as we move forward, that if the prices are falling in the existing home market, there is some sort of reliance that the builders, public and private, are generally not going to try the compete with that decline in pricing by cutting their own price and moving forward?

I'm not sure, I understand.

Well, in other words, you have had a price (inaudible) in your existing homes for a while because you cut your prices as you noted earlier in the comments, right? And now as existing home prices come down, isn't there some sort of belief that new home builders are not going the cut prices to keep that advantage?

I -- well, I think right now as we've mentioned on prior phone calls, we're in a bit of an odd scenario, because the new home -- the public home builders have reduced their prices rapidly, because we want to keep inventory moving. Existing home prices had not dropped as rapidly, and that is part of the reason why resales were more sluggish and the inventory was more sluggish than the new home builders new home inventory. And it got to a scenario whereas typically new home prices are at a premium to used homes, used homes asking prices were at a premium to new homes, which is unusual. I would imagine that it is likely we'll see more reduction in the existing home prices than builders new home prices right now, and get back to a more normal relationship where a home buyer values a new home and pays a premium for it versus a used home.

And the next question comes from the line of Michael Rehaut from JPMorgan.

Good morning, this is Jen Consoli on the line for Michael. My first question was, you talked about you had largely stopped buying land in some of the more challenged buying markets. But I was wondering if you could go through some of your regions and talk about what are seeing in terms of bid out spreads? Are there any markets at all where you see that spreads are tightening, and you would be more inclined to take advantage of opportunities, given your improved liquidity?

Generally speaking at this moment, other than perhaps Houston, Texas, we do not see sensible land transactions where we can make a good solid profit at today's housing prices and today's housing paces and velocities. So we are being patient, even with the enhanced liquidity, even as we're about to finalize a joint venture partner, I would not anticipate us being particularly active at this moment. Remember, and as you know, we have been through many of these cycles, and patience is a virtue. What we -- we don't want to buy a property that only works when the recovery happens. We -- our buy signal is when you can make a good economic return with enough margin -- room for margin for error at today's sales -- house sales prices and today's house sales paces. And generally speaking we are not at that point anywhere in the market in the country, we're -- other than Houston. We're looking -- we're keeping our ear to the ground, but we're not there just yet.

Okay, great. And in terms of the future costs saving initiatives, you have gotten some benefits there. But is it coming to the point where you're reaching either a critical mass in terms of head count, that incremental benefits going forward may be limited, or is there still low hanging fruit that you can take out of the cost structure?

Low hanging fruit has been eaten a long time ago. And we're on our ladders in this regard, both in terms of our staffing levels and in terms of subcontractor costs. Having said that, we have reduced our head count from a peak of about 6,800 to a little over 3,100. That is a dramatic cut. There are more opportunities, if you can call them that, if we have to do it and the sales slow down even further. We are staffed to deliver and handle our current business volume. If volume slows down more, we may not be able the cut staffing proportionately, but we'll definitely be able to continue reductions. It is not low hanging fruit, it is painful. We hope to be able to avoid it, but we'll do what we have the do as we have in cycles in the past.

Regarding subcontractors in the area -- and the material costs, commodities are commodities, thankfully they have been moving in a reasonably good direction, particularly in the area of lumber, one of the key driving costs in home building. Then we're really down to the labor component. I think -- the subcontractors generally speaking are not making a profit today. They're just hoping to cover their overheads, and their overhead costs have been coming down because they were able to pay their laborers lower rates. So the easy cuts have been done, I wouldn't call them easy, but the lower hanging fruit has been picked. And it is going to be more challenging, but there are still opportunities in that area too.

And the next question comes from the line of Nishu Sood from Deutsche Bank. You may proceed.

Thanks. Hello, everybody.

Hello.

First question I wanted to ask was on your gross margin. Coming into your fiscal year, you had told us that because of think it was about 1,400 Fort Myers closings, which would be happening at close to zero gross margin, we'd probably see a lift in gross margins post the first quarter. But it looks like they came pretty close to the first quarter. So I was just wondering if you could walk us through the dynamics there, what drove that?

First, I think you may have misinterpreted what we said. I think what we did say is that the Fort Myers closings dragged down our margin at that time. I believe something just under a 2% effect, maybe 1.7%, 1.8% effect at that time. I don't think we were projecting gross margins for the future quarters.

Okay, so following up on your actual question, I think there was a couple of things that caused margin pressure in the second quarter. And I touched on them in my prepared remarks. One of them is our focus on trying to sell some of the started unsold homes, which we made significant progress on during the second quarter. And those are typically sold at lower margins than to-be builts. And the other is just the reality of the deterioration in home prices that occurred during the second quarter that led to us booking additional impairments. So there has been changes since the last time we had this call that reflective in our results.

Right, okay. And the follow-up question, the last time -- I think this is a question that is being asked of a lot of the builders. Interest in knowing of your owned lots, the kind of development stages of them. The last time you said you might look into that. I was just wondering if you could give us an update and help us understand what percentage of your lots are developed, and not fully developed or raw.

We just don't track the data that way.

But, however, I'd suffice it to say that the land development expenditures are down dramatically. And we do have a large amount of developed lots ahead of us. And that's advantageous for cash flow. It is one of the reasons we're projecting more positive cash flow going forward now.

And the next question comes from the line of Alex Barron from Agency Trading Group. You may proceed.

Yes, hi, guys how are you going?

Good, Alex.

I wanted to ask you what are the total number of communities or percent of your total that has been impaired at least one time since the beginning?

Do you have another question, because we don't have it as a percentage. We'll try to figure it out and give you an answer before the call or afterwards, Alex.

Okay, sounds good. Yes. I guess another question I had was if you could walk us through I guess some of the major -- how you're thinking about the $300 million between now and year end. Where does that come from? Does it come from land sales or reducing further spec count, or is it closing out communities, or what are the major components how we get there?

There is no specific unusual items in that number. I mean there is a tax refund, but the tax refund is the same as it was back when it was when we originally made our projection in the year earlier, so that number hasn't changed. As I mentioned earlier, we're not anticipating any bulk land sales. So that's not impacted. So it is just kind of an ongoing operation from what we expect to generate from selling our homes and our renegotiation efforts on delaying the purchases of land that are currently under option and the land development or walking away from communities that we were otherwise planning to spend money on previously. So that's kind of the overall big picture. There is nothing really unusual in the numbers.

And the next question comes from the line of Joel Locker from FBN Securities, you may proceed.

Hi, guys, just -- I wanted to talk about your west region for a little bit. Just so the order of decline was on a little less on a unit basis than the company, only down 17%. But yet dollars fell more than any other part, being down 31%. And just wanted to see if you had some kind of push in the west, just because your own lot counts may be higher there on the absorption rates to move homes.

No, we really didn't have a dramatically bigger push there. So I haven't focused on that fact -- that you just mentioned. But my suspicion is that it may have to do with mixes, part of it, as we're winding down perhaps on some of our higher end, coastal locations, more rapidly at the moment.

So I mean and therefore the price drop might have been more based on inland communities that sell at a lower price?

More of inland community sales versus the coastal community sales, we are closing out of several of our coastal communities.

And the next question comes from the line of Paul Formanko -- I apologize for the mispronunciation of the last name, Formanko from (inaudible). You may proceed.

Yes, hi, this is Steve [Getemal], a colleague of Paul Formanko's. Ara, our question is, you said earlier in the call that your end of your cash balance should be around $800 million. And the idea was to be defensive and to focus on the balance sheet. But with the recent debt offering of the [11.5%], you still have a number of bonds that are trading substantial discounts to par. What are the thoughts on that? Would -- it seemed like you got a negative interest arbitrage where you have cash sitting on your books, this $800 million, probably earning 2%. And meanwhile you have got bonds, in the high [60s], maybe mid [70s] that have probably current yields in excess of 10%. Would you -- is there thoughts to may do some open market purchases and retire some of this debt?

At the moment the main reason we issued the new capital was, we just felt we needed to get an insurance policy, if you will, on liquidity. At this point, until we get a clearer picture on the market, on when the bottom is going to come, on what the effect is of foreclosures or price decreases, I -- we're not overly anxious to -- in spite of the fact that it's quite enticing, we are really placing a premium on capital and liquidity, because it's not easy to obtain in this marketplace. So right now, we just want to -- generally speaking, we want to sit tight and see where the market is going and where the bottom is.

And --

We said that when we raised that money -- because that was a question that came up. So I'll just reiterate what Ara said is, liquidity is the primary issue we want to make sure that we have sufficient capital to weather the storm. And we don't know how long the storm is going to last. The second kind of priority is we want to have some dry powder to pursue opportunities at the bottom of the cycle, and I would rank opportunistically buying back bonds below both of those priorities. So I just think it's premature to expect us in the market.

I know, I mean, having said that we will always constantly look. It is clearly not a high priority for us at this point in spite of the negative arbitrage.

Okay. Well, thank you very much.

(OPERATOR INSTRUCTIONS) And the next question comes from the line of Megan McGrath from Lehman Brothers. You may proceed.

Thanks. Hi. I just wanted to ask a couple of question. First on your level of promotions. I guess how would you characterize where you are today versus maybe two or four months ago in terms of the number and level of promotions that you're doing?

Well, I'm not sure precisely what you mean by promotions. But if you mean concessions, or incentives like free upgrades, etc., I would say generally they are about level. Now having said that, there are points when we continue and the market continues to add to concessions or incentives, there is a point at which you're better off setting the base price and reducing the amount of promotion and incentive. That is happening a little more frequently. And we're just kind of resetting prices. But regardless, frankly, we don't particularly focus on base price versus incentive. We look at net-net sales price. And obviously that has been challenging and has been creeping down over the last quarter. Regarding national promotions or major sales promotions, similar to what we did last September, the deal of the century, I would say we are not overly focused on that. We think we can get similar results by just continuing to deal on a community by community and home by basis.

Okay, thanks that is what I was after. And then a follow-up on your capital raise. You'd said that part of the reason that you did that you did it was to anticipate -- you were anticipating potential further tightening by some of the banks. Curious if you had sensed any of that potential tightening or were trying to anticipate it from some of your suppliers or subcontractors who have certainly been hit when all the privates have gone under. Have those relationships changed at all?

Not at all. No. They've -- both in terms of and subcontractors, it's been solid. We have been very conscientious in making sure our payment track record is excellent. And those relationships are solid across the board.

And the next question comes from the line of Timothy Jones from Wasserman & Associates. You may proceed.

Good morning, first question is your land and options for future development or sales went up $180 million. Can you tell me, was that a switch out of inventories? And what percentage of that is options as opposed to land?

It was primarily because we bought all of those communities and switched it, Tim. It wasn't new stuff that we bought.

But how much of that -- what percentage of it is options?

Anybody know?

$119 million is the total -- and that has been going down.

$75 million was cash.

But in general, the dollars spent on options or invested in options has been going down regularly. So again to clarify what -- to reemphasize what Larry just said, if we mothball a community, then it goes in land and planning. So it's really a switch from one category to another.

So most of this is mothballed land?

Yes.

Okay. Then the other question is, if we -- just explain the variable rate entity, the other options, is that what you mean by options? And the deposits and notes receivables. What are those three?

I'm not sure I heard whole question. Did you ask what the variable interest inventory is?

Would you explain the variable interest entities, the other options, and the deposits and notes receivables?

Okay, the variable interest entities and the other options inventories are inventories that we've been required to book for GAAP for different FAS announcements, whereby we have the items under option. And under the FIN 46, you're required to look at the rules as to who is the primary beneficiary of the property. And you have to book -- if you meet those requirements and are considered the primary beneficiary, you have to record the inventory on your books with the corresponding liability or minority interest. So if you look on the liabilities side, those inventory that are in the inventory not owned section are effectively off set by liabilities, but they're options that we could decide not to exercise. And the only thing we're exposed to are the deposit on those items, not the full amount of the inventory. The same is true with other options. It's predominantly our model that we have under option with GMAC, they basically own our models, and we have the option to buy those from them. We reflect them on our balance sheet as inventory for GAAP purposes. But again we don't have to buy those models. We could walk away from them and they go back the GMAC. So in -- those cases, they're not our full exposure. It's always much smaller numbers, the deposits we have on those options.

And then your last question was receivables deposits and notes, that is principally -- the receivable portion is principally the net due at closing. So when we close homes if we haven't received the cash yet because it hasn't come from the title company or it's in the closing process, it's usually a day or two later when we get that cash. That is the receivables. The deposits are deposits that we have in place, the community that is we have deposits with municipalities or utilities, etc. There's very few notes in there, there's some very minor miscellaneous we might have, but nothing of significance. It is predominantly the net due at closing and the deposits we have the existing municipalities, etc. related to our communities.

This is all fully disclosed in our Qs and our Ks. So when --

It isn't going to change. They don't change.

That's correct. If you want to go back and get more details you can get more from the new Q coming out at the end of the week.

And at this time we don't have any further questions in the queue. I will pass the call over to Mr. Ara Hovnanian for closing remarks.

Thank you very much. As you all know it is a challenging housing market, but as I said in my closing comments, housing is here to stay. The market will ultimately recover, and we plan to be a major participant in that recovery, hopefully in the not too distant future. We'll continue to work hard and look forward to giving you an update next quarter. Thanks so much.

This concludes our conference call for today. Thank you for your participation and have a nice day. You may now disconnect.